Is The Cost Approach Flawed?

[Howard Klahr]

So, have estimated market value? Or have we just provided another data point in our overall analysis?

The ridiculous example you have provided doesn't deserve a comment but I'll take that one and raise you a sports stadium and a nuclear power plant. Now what approach do you plan to use there?

Rather than trying to provide the isolated example why cant you stay within the discussion topic of the thread and actually help educate some that are less fluent with the details of performjng the cost approach properly?

 

[Joe Flacco]

Cost approach is great. Important to develop the site value properly.

 

[Meandering]

Thanks Howard and I did belive the OP knew what she was talking about.

And Terrel is correct about the obsolescence for vacant and ready, but really is that “market value” for the site with a house in it, to discount the value of the land because no new house can be built? All my years I have never heard of a buyer or a seller concerned about that, maybe because many places allow for replacement under a grandfather clause, which then negates the obsolescence and makes lenders and reviewers blow a cork, but not buyers and sellers. Yet “the market” is the buyer and seller reactions.

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[Terrel L. Shields]

All my years I have never heard of a buyer or a seller concerned about that, maybe because many places allow for replacement under a grandfather clause, which then negates the obsolescence

Maybe... But by valuing land as if vacant and available for its highest and best use, you solve the HBU problem of current use. You then have the basis for developing a value of the actual contribution of the improvements "as is". If an older house is located in an area where vacant commercial land is sought, then the land value speaks of the relative amount of external influence on the contribution of the improvements.

When a lender lends a 30 year note on an older house whose land value is more than the value of a similar home in a true residential area, they risk lending too much on a home that may have a much shorter lifespan than 30 years.

 

[Ariba]

Cost approach is great. Important to develop the site value properly.

In a metropolitan area what would be the purpose?

In a metropolitan area with plenty of good comparables can anyone provide any rational and/or reason were the CA would add any credibility to the appraisal report? Has anyone used the cost approach to arrive at an opinion of value when there are plenty of comparables in the market area?

 

[Joe Flacco]

In a metropolitan area what would be the purpose?

In a metropolitan area with plenty of good comparables can anyone provide any rational and/or reason were the CA would add any credibility to the appraisal report? Has anyone used the cost approach to arrive at an opinion of value when there are plenty of comparables in the market area?

The sales comparison approach and cost approach go hand in hand. For example, a subject is 1,600 SF and is worth $1.1 million. That would say the property is $687.5 per SF. The cost approach shows that the site value is $1 million. So in reality the depreciated improvement is being valued at $62.50 per SF. It helps explain why the adjustments in the sales comparison approach might be what they are. When site values are a high percentage of value, then adjustments related to the site such as size or location might be relatively large and adjustments related to the improvement might be relatively small.

Not only that, researching site values for every subject property over the years has improved my understanding of my local market at the micro level significantly. I have not seen many reports that suggest the site value was developed properly.

 

[hastalavista]

The sales comparison approach and cost approach go hand in hand. For example, a subject is 1,600 SF and is worth $1.1 million. That would say the property is $687.5 per SF. The cost approach shows that the site value is $1 million. So in reality the depreciated improvement is being valued at $62.50 per SF. It helps explain why the adjustments in the sales comparison approach might be what they are. When site values are a high percentage of value, then site size adjustments might be relatively large and adjustments related to the improvement might be relatively small.

Not only that, researching site values for every subject property over the years has improved my understanding of my local market at the micro level significantly. I have not seen many reports that suggest the site value was developed properly.

What you describe is, IMO, what is described below (From the Assessor's Handbook- "Basic Appraisal")


In your example, we can deduce that the improvements, as they exist, are nearing the end of their economic life. If significant remodeling isn't a "do it now" decision, it soon will be (or, demolition).

 

[Mr Rex]

Conversely the Cost Approach is probably the least universally applied approach from the typical market participant in most markets. Unless comparing new properties, the average market participant could give a rats arse about depreciated costs with a nominal nod and wink to costs new relative to costs of existing.

 

[NC Appraising]

Is it flawed? Yes.

The Sales Approach is flawed too.

https://www.eastwoodhomes.com/index.php/find-your-home/neighborhood/glendalough

PS, ever wonder how the same model in different PUD in a much more desirable neighborhood can sell for $100k more? Yes, land is more expensive, but not that much more...bigger risk ..bigger reward?

Check out the Hamilton and Mcdowell model. $10,000 difference, similar GLA. (hint: two story great room). Now what about the difference in upgrades? One could have $5,000 and one could have $50,000. Where in M&S are the upgrades or the difference in the great room. There are none. Square foot method flawed. What if this home was a 1 year old re-sale and no longer a new home with the builder spoon feeding you the data?

I would say that 90% of the cost approach that appraisers use are fudged, made up or highly inaccurate.

Also, check out some old FHA/HUD docs on how to complete the cost approach. That last line is there for something....Also compare the example in the M&S to the URAR.


Site value.....using the cost approach.....

Here is a school assignment for you.

Go into a established subdivision and look for sold vacant lots. Hard to find, but they are out there. Subdivisions that were built in the 1950's-1970's Try to find some tear downs also for further comparison. Go a little back in time if need be.

Now you know the site value (all else is equa...no heavy sloping lots, flood zone, etc)

Now do the cost approach on several of the closed sales within the same subdivision. More than likely you will get a gap in the numbers or the "flawed data". You know, the huge gap or what makes you scratch your head say this isn't right?

If you did not know the site value and used the allocation or extraction method......that gap in the numbers. Most appraisers would simply add it back into the site value or play with the depreciation or ppqft. But is it EA or something else. M&S tells you in the instructions what is not included......

This can apply to new construction in PUD developments where prices are rapidly increasing. Site value may not be really worth that much......builder is just making more profit.....cannot throw all of the fluff in the site value or the price per sqft section of the cost approach.

To end, remember that some of the data is subjective. Buyers are subjective. Our data is subjective and flawed. National builder, local builder..volume lowers costs...paid to much for land?...one cost provider is not the final word.

So that gap is some where. You may not find it all, but those lines, well mainly the one that is always left blank near to bottom of the cost approach needs to be utilized..

 

[Michigan CG]

Unless comparing new properties, the average market participant could give a rats arse about depreciated costs with a nominal nod and wink to costs new relative to costs of existing.

But it is amazing how consistent the sales are and how consistent the derived depreciation is.....................